What Is A Fair Price to Pay for FirstREIT & PLifeREIT amidst Rising Interest Rates?

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A Real Estate Investment Trust or REITs for short are a type of professionally managed collective investment scheme with its primary business being the acquiring, owning and financing of income generating real estate. REITs have the benefit of providing investors with a regular income stream and prospects of long term capital appreciation.

For more information on how to analyse and invest in REITs, make sure you check out our related articles on REITs here:

Due to is steady stream of income derived from rentals of its underlying real estate assets, REITs are frequently viewed from a yield perspective.

To know if a particular REIT is trading at a price that is returning a good yield, investors may compare the REIT's DPU Yield against known risk-free rates to calculate the REIT's yield spread.

Last week, we looked at the yield spreads of Fraser Centrepoint Trust (FCT) and also discussed the concept of yield spreads. The article generated a vast amount of interest among the investment community online. do check out our previous article on FCT if you missed it.

Due to the popularity this method of analysis, we decided to repeat this analysis by look at the yield spread of the Healthcare Sector REITs which comprises of First REIT (FirstREIT) and Parkway Life REIT (PLifeREIT).

To know if a particular REIT is trading at a price that is returning a good yield, investors may compare the REIT's DPU Yield against known risk-free rates to calculate the REIT's yield spread.

The risk-free rate is the annual interest an investor would earn if investing in an asset that is considered absolutely risk-free. Typically, the risk-free rate would be the bond yields of a highly rated bond from a sovereign nation. In the case of Singapore, the 10-Year Singapore Government Securities (SGS) can be used as the reference risk-free rate.

At the time of writing, the 10-year SGS is currently trading at a yield of about 2.50% to 2.75%.

A yield spread is the difference between yields of the REIT under analysis against the risk-free rate. The yield spread will provide a measured gauge of the risk premium when investing in the REIT.

The chart above is the historical Yield Spread (%) chart for Healthcare Sector REITs which comprises of First REIT (FirstREIT) and Parkway Life REIT (PLifeREIT) against the Singapore Government Securities (10-year SGS).

Since 2012, the average trailing yield for the healthcare sector REIT is 5.19% while the average yield spread is approximately 2.91%.

At the current point of writing, the marketcap based weights of the 2 component Healthcare Sector REITs are 40.35% and 59.65% to FirstREIT and PLifeREIT respectively.

At the moment, the yield spread for Healthcare Sector REITs is approximated to be 2.77% which is not far from the mean of 2.91%. This indicates that the healthcare REITs are generally trading just slightly above their historical fair values.

For both the healthcare REITs to reach a good buy opportunity of at least 1-StdDev above the mean yield spread, FirstREIT and PLifeREIT would need to trade at approximately $1.235 and $2.355 respectively.

FirstREIT and PLifeREIT closed the week at $1.34 and $2.60 respectively. Therefore a fall to the 1-StdDev yield spread level would represent a price correction of approximately 7.8% and 9.4% respectively.

If you are planning your entries for REITs, make sure you enter at a level that gives you a high margin safety. Using the yield spread is one good method to estimate a good entry price with a comfortable margin of safety.

Will the market present investors with such a bargain? Based on the current FTSE ST REIT Index last close of 778 (22-Jun-2018), a 10% fall would bring the index down to the 700 to 710 range. It doesn't seem impossible in our view especially with the rapidly rising interest rates.

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If you would like to learn more about REITs, make sure you check out our most popular post related to REITs and Business Trusts. We hope that you will gain much insight from our coverage of this sector:

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